Every blow up avoided improves the performance of your portfolio.
Management faces crushing pressure to make things appear better than they are.
Management tortures the numbers to "beat by a penny" and to keep the Wall St analyst predators and their dreaded downgrades at bay.
Aggressive accounting may not be illegal, but its chicanery. Sooner or later, hard and long aggressive accounting can try to entomb the bodies, they rise like zombies, until the company misses huge and the zombies suck management brains and investor profits through stock downgrades and selling.
The job is to analyze earnings quality.
The book may place revenue recognition and inventory management next, but every part of the financials connects with another. "Earnings" is the financial picture as a whole.
Rising days sales outstanding or days sales in inventory may be the two great single indicators of trouble in the next quarter or several.
Showing posts with label accounting. Show all posts
Showing posts with label accounting. Show all posts
Wednesday, July 2, 2014
Tuesday, March 25, 2014
The Art of Short Selling - Wealth With Risk
Short sellers unearth facts from financial statements and from observation to ascertain that a stock is overpriced. Short sellers are information-based traders. Before 1983, no solely short funds existed. Stocks can only go to zero on the way down, but can go to infinity on the way up (reply: I've seen a lot more stocks go to zero than to infinity). Short sellers take greater risk than other investors - they must have strong evidence to support cases for price declines. Becauses reverses are sudden and terrifying, the burden of evidence rests on a solid, careful analysis completed before the stock is shorted.
Short selling is a niche. It is very small relative to the stock market as a whole. The long bias of and in the market creates exploitable inefficiencies for shorters, ie. there are more overpriced stocks than underpriced stocks (Asquith and Meulbroek). Negative earnings surprises affect stock prices to a greater degree than positive earnings surprises, and that effect persists over time. The common wisdom that there is no such thing as one bad quarter has a statistical basis. Stocks become torpedo candidates when very high expectations give way to earnings disappointments.
Short sale candidates cluster in three broad categories:
The trail signs to look for:
Accounting-based analysis is not difficult to do, but it takes time, patience and a suspension of belief.
The lack of attention by other professional investors to financial details provides the inefficiency in information dissemination that is so central to the short sellers art.
The goal is to identify the tragic flaw in a business long before the company's demise (the death rattle of a company in decline). The art of short selling trains analysts to avoid torpedo stocks or to profit from them.
The main weakness of short sellers is the inability/difficulty in judging the timing of collapse. Short sellers are consistently years too early when they sell stocks. Short sellers fear most a sustained rally in a stock.
How to make money in short selling and how not to lose money by selling are different sides of the same coin.
Short selling is a game of wits with the odds in favor of the analysts who do hard work and think for themselves, who turn jaundiced eyes on what passes for Wall St wisdom.
Short selling is a niche. It is very small relative to the stock market as a whole. The long bias of and in the market creates exploitable inefficiencies for shorters, ie. there are more overpriced stocks than underpriced stocks (Asquith and Meulbroek). Negative earnings surprises affect stock prices to a greater degree than positive earnings surprises, and that effect persists over time. The common wisdom that there is no such thing as one bad quarter has a statistical basis. Stocks become torpedo candidates when very high expectations give way to earnings disappointments.
Short sale candidates cluster in three broad categories:
- Companies in which management lies to investors and obscures events that affect earnings.
- Companies that have tremendously inflated stock prices - speculative bubble.
- Companies that will be affected in a significant way by changing external events.
The trail signs to look for:
- Accounting gimmickry: clues that the financial statements
- Insider sleaze: inurement, insider sellling.
- Fad or bubble stock pricing: large price rise over short period.
- A gluttonous corporate appetite for cash.
- Overvalued assets or an ugly balance sheet.
Accounting-based analysis is not difficult to do, but it takes time, patience and a suspension of belief.
The lack of attention by other professional investors to financial details provides the inefficiency in information dissemination that is so central to the short sellers art.
The goal is to identify the tragic flaw in a business long before the company's demise (the death rattle of a company in decline). The art of short selling trains analysts to avoid torpedo stocks or to profit from them.
The main weakness of short sellers is the inability/difficulty in judging the timing of collapse. Short sellers are consistently years too early when they sell stocks. Short sellers fear most a sustained rally in a stock.
How to make money in short selling and how not to lose money by selling are different sides of the same coin.
Short selling is a game of wits with the odds in favor of the analysts who do hard work and think for themselves, who turn jaundiced eyes on what passes for Wall St wisdom.
Thursday, December 13, 2012
The Achilles Heel of Capitalism
Taleb makes the point that the achilles heel of capitalism is that if you make corporations compete, it is sometimes the one that is most exposed to the negative Black Swan that will appear to be the most fit for survival.
I have made a similar point previously. Basically, those companies that appear to be "best in breed" are oftentimes those that are the rottenest, ie. they are cooking the books (eg. AIG).
I have made a similar point previously. Basically, those companies that appear to be "best in breed" are oftentimes those that are the rottenest, ie. they are cooking the books (eg. AIG).
Tuesday, August 18, 2009
Red Flags In Surprising Places
I screen a lot looking for quality companies. Quality companies are not hard to identify. They are companies with above average growth rates, above average profitability, expanding margins, positive earnings surprises, low debt levels, high operating leverage, etc., etc..
I was watching William Black's presentation "The Great American Bank Robbery" and it reminded me of some thoughts. Namely, that the naive process of screening for "quality" companies often throws up a number of duds and dupes. These are companies that look good on paper, but are rotten beneath the surface. Black refers to red flags related to companies exhibiting huge growth rates, monster margins and always beating the number. He argues that the growth rates and the "always beat" are often hallmarks of an environment where bad ethics is driving out good ethics. The weapon of choice for white collar crime is accounting fraud. Sometimes, when it is too good to be true, it is too good to be true.
Foreign companies (especially Chinese companies) often exhibit these characteristics, so it is always buyer beware. However, the measure I have come across to cross reference the quality of a company is the level of short interest. The short guys (at least those who specialize in it and not necessarily the hedge guys who simply run long/short portfolios) always seem to sniff out accounting fraud, or a broken business model, or a company/industry in secular decline, or fads. They do their homework and have a healthy dose of skepticism.
Black, to his credit, also holds no punches when he calls the Big Four accounting firms and the credit rating agencies failures - ouch!
I was watching William Black's presentation "The Great American Bank Robbery" and it reminded me of some thoughts. Namely, that the naive process of screening for "quality" companies often throws up a number of duds and dupes. These are companies that look good on paper, but are rotten beneath the surface. Black refers to red flags related to companies exhibiting huge growth rates, monster margins and always beating the number. He argues that the growth rates and the "always beat" are often hallmarks of an environment where bad ethics is driving out good ethics. The weapon of choice for white collar crime is accounting fraud. Sometimes, when it is too good to be true, it is too good to be true.
Foreign companies (especially Chinese companies) often exhibit these characteristics, so it is always buyer beware. However, the measure I have come across to cross reference the quality of a company is the level of short interest. The short guys (at least those who specialize in it and not necessarily the hedge guys who simply run long/short portfolios) always seem to sniff out accounting fraud, or a broken business model, or a company/industry in secular decline, or fads. They do their homework and have a healthy dose of skepticism.
Black, to his credit, also holds no punches when he calls the Big Four accounting firms and the credit rating agencies failures - ouch!
Thursday, April 30, 2009
Do I Trust Them?
Do I trust companies? No! Directors? No! Management? Who are you kidding!
I can't tell you how many times I have seen companies beat the number this quarter, but miss on revenues. If that isn't a fudge I don't know what is.
Usually, they beat on both the top and bottom line. But this time around they are beating only on the bottom line. Demand is evaporating, but somehow they manage to meet the number. Come on. I call accounting shenanigans, but there again, what is new.
I can't tell you how many times I have seen companies beat the number this quarter, but miss on revenues. If that isn't a fudge I don't know what is.
Usually, they beat on both the top and bottom line. But this time around they are beating only on the bottom line. Demand is evaporating, but somehow they manage to meet the number. Come on. I call accounting shenanigans, but there again, what is new.
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